Many factors play roles in determining home loan interest rates. Some of these things are structural and economic, and others are because of the terms that you accept when you take out a new home loan.

The Prime Interest Rate

The prime rate is the lowest rate offered by banks for commercial lending; the Wall Street Journal publishes a periodic survey of lenders about their current rates. Those current rates come from the Federal discount rate, set by the Federal Reserve; which the banks pay to borrow funds from the Fed and that they then offer to clients at anything from the prime rate upward. Only the most strongly favored customers can borrow at the prime rate, but it is a benchmark level of the markets for the rest of us.

Home Lending Market Supply And Demand

Banks earn their income by borrowing from the Federal Reserve’s discount window and taking in deposited funds and lending that capital to other customers as interest-bearing loans. The rates that they charge depend on what customers are willing to pay to get access to cash. The banks provide the supply and charge interest rates that will support the demand from borrowers.

In an open market that has competition between many lenders seeking to attract many borrowers, the rates of interest reflect these levels of supply and demand. Of course, it is never as simple as that; some borrowers are worthier of trust than others, as determined by the credit rating agencies, and they will receive preferred rates on their loans. Those customers that appear to be riskier will pay higher rates.

Prime rates and the economics of supply and demand set the background of the economy and the lending market. Now let’s look at the differences in the types of loans.

The Two Things That Define Low Rate Home Loans

Adjustable rates mean safer investments for banks – Lenders like to know that, if conditions change, they can update the interest that they charge occasionally. The adjustable rate home loan faces strict statutory limitations on how the rate can change but even so, lenders still have more flexibility than fixed rate loans. When banks can update at least once during the term, they offer slightly lower rates of interest in return.

Shorter terms mean better cash flow and less risk – When a loan has a shorter term it earns less interest than longer ones. But lenders can always replace a completed loan with new lending. The shorter term means that there is less time in which something can go wrong, and the higher repayments of principal mean more cash flow. Lenders will give lower rates in return for larger monthly payments.

So, in exchange for faster principal repayment and the right to adjust your interest rates banks and finance companies will give you the lowest rate on your home loan.

Choose Your Terms And Buy Your Home

From the principles discussed above, the lowest rates are for adjustable rate loans with a fifteen-year term. The conventional choices for term length are between thirty and fifteen years, without stretching too far into customized territory the best deal will be with a fifteen-year loan. It will be a better rate if you accept an adjustable rate loan. The question is whether you want to take the risk of there being unusual economic conditions at the time that the lender sets the new rate.

Whether you have excellent credit or not, some options for home loans will be less expensive than others. The structure of the lending market and the regulations around it mean that the best rate you are likely to receive for a home loan will be for a fifteen-year adjustable rate loan.